Act 1: England, 1830s. After the death of their father, Nicholas Nickleby and his sister Kate, together with their mother, leave their home in Devon and travel to London to seek help from their uncle, Ralph Nickleby, a wealthy and ruthless financier and money-lender. Ralph criticises his late brother for his selfishness and profligacy in being unable to provide properly for his family, and sternly insists that the children must make their own way in the world. However, he draws Nicholas's attention to an advertisement for a new teacher at Dotheboys Hall in Yorkshire, run by one of his clients, Mr Squeers. Nicholas expresses a willingness to accept the post and, after an uneasy interview with Squeers, departs with him for Yorkshire. Ralph Nickleby's clerk, Newman Noggs, who has no affection for his employer and is clearly distressed at the arrangements that have been made, promises Nicholas he will keep an eye on his sister and mother and offers friendship and help when required. Kate secures employment at the home of a milliner and dressmaker, Madame Mantalini, and Ralph finds new lodgings for her and her mother in the East End of London.

At Dotheboys Hall, Nicholas is shocked at the malnutrition of the children and appalled by their brutal treatment at the hands of Squeers and his equally unpleasant wife. He is further embarrassed when Squeers' daughter, Fanny, conceives a passion for him and anticipates a proposal of marriage. He is particularly concerned at the condition of one of the older boys, Smike, who was abandoned at the Hall twelve years previously in mysterious circumstances and has suffered both mental and physical degradation ever since. When Smike attempts to run away, he is captured and brought back for punishment. Squeers' savage beating of Smike rouses Nicholas to a fury and, ignoring Squeers' violence towards him and instruction to leave the room, he thrashes the schoolmaster before escaping from the school and resolving to head back to London. Smike follows and, now utterly devoted and loyal to Nicholas, asks if he may accompany him: Nicholas agrees. Back at the hall, Fanny is writing a furious letter to Ralph Nickleby, informing him of Nicholas's attack on her father. She is interrupted by a mysterious caller, Mr Brooker, who says he has come about a boy.